Armour Residential Preferred C: On The Path To Par (NYSE:C)

The discharge of the minutes from the Federal Open Market Committee’s September assembly solely intensified the talk on the trail and tempo of rates of interest. This information adopted the Bureau of Labor Statistics’ October 4th report of a bigger than anticipated 254,000 jobs improve in September. The impact within the futures market was to evaporate the anticipation that the Fed would repeat with one other 50-basis level charge lower at its November seventh assembly.

Supply: CME Group Fed Watch

Consensus nonetheless holds that decrease is the path of rates of interest, however that also leaves fixed-income buyers guessing as to how far and how briskly. Our two-fold goal of securing larger yield for the long run, coupled with some capital appreciation, stays intact. At the moment we’ll try to forecast how funding in Armour Residential REIT 7.0% Collection C Most popular (NYSE:ARR.PR.C), one among our long-time favorites, will play out beneath present expectations.

The Problem and the Issuer

Armour Residential REIT (NYSE:ARR) is an company mREIT with a present frequent inventory market capitalization of roughly $1B. They lever that fairness up roughly 8x to handle a fastidiously hedged $11.4B portfolio of U.S. Authorities-sponsored mortgage-backed securities.

Supply: ARR 9/30/24

That frequent fairness and the revenue the portfolio generates present a adequate capital cushion for us to really feel assured in the popular shares as a hybrid, fixed-income funding, and we’ve been lengthy, to various levels, ARR.PR.C for nearly 5 years now.

Supply: Portfolio Earnings Options

The $171MM face worth of the popular issuance is senior to the frequent and carries a set 7.0% coupon. The difficulty is callable after 01/28/2025, however the current rate of interest surroundings and administration’s expressed satisfaction with the preferreds mounted coupon construction make us imagine the problem received’t be known as any time quickly. At present market costs, new purchases seize an approximate 7.5% yield, however that dividend is just a part of what we’re after.

The Quick Path to Par Pricing

When the Fed started its inflation-fighting, rate-hiking marketing campaign in March 2022, bond markets headed decrease and low-liquidity mounted revenue devices, like most well-liked shares, turned considerably extra dislocated. Early on within the rising rate of interest surroundings, we homed in on fixed-to-floating charge preferreds to safe fairness and yield protections whereas the extent of charge will increase was but unknown. Now that the Fed has begun reducing charges, we will extra definitely verify the final word worth of mounted coupon points.

After the Fed lower charges, our preliminary inclination was to concentrate on the 10Y T-Be aware yield to estimate the relative market enchantment to high-coupon, discounted preferreds. Nonetheless, we shortly got here to witness the yield curve’s dis-inversion and whereas shorter time period charges had been certainly falling, longer period charges had been truly rising.

Supply: S&P Capital IQ

Regardless of this charge pattern, our anticipation that most well-liked share costs would rise nonetheless appeared appropriate. Reductions started to shrink, and lots of most well-liked problem costs have risen towards par. Our expectations are being realized; we simply misgauged the driving trigger.

A Cash Market Fund Mountain

In prior commentary, Dane Bowler noticed that cash market fund balances had swelled to greater than $6T, nearly double their historic norm.

Incomes a riskless 5%+ return on idle money clearly has a whole lot of enchantment. Crane Knowledge describes that funds are nonetheless flowing into cash markets however which will change if yields drop sufficiently.

Even when the Fed slows or stops reducing rates of interest, it’s important to be a little bit bit in awe of the amount of cash fund curiosity revenue that must be reinvested. REIT preferreds received’t be the probably vacation spot for capital flowing out of cash market funds, however $300B dwarfs REIT preferreds buying and selling quantity.

Supply: 2MCAC

If declining yields trigger trillions to movement out of cash market funds in pursuit of higher returns, it can accomplish that in an surroundings of yield shortage. That shortage will make buyers contemplate riskier choices to safe yield, and most well-liked shares will develop into extra enticing.

Restricted however Engaging Upside

As lively mounted revenue buyers, we’re drawn to the 7%+ yields out there in REIT preferreds at present. You may seize a 7.78% yield in buying AGNC Funding 7.75% Most popular Collection G (AGNCL) at at present’s closing value of $24.90. We discover discounted points like ARR.PR.C much more enticing in a declining yield surroundings as a result of we will safe a excessive dividend revenue and potential capital appreciation. If at present’s $23.40 share value is pushed to par in a yield scarce surroundings, that’s a 6.8% achieve so as to add to the 7.47% dividend yield; if charges fall shortly, the mixed annualized return might exceed 10%.

Dangers of the Future Unknown

Latest financial reporting has dampened expectations for the tempo of rate of interest declines. If the Fed considerably reduces the pace at which it cuts charges or stops reducing fully, the sought-after capital appreciation won’t materialize. Returns could be capped at dividend yields.

Nonetheless, whereas enthusiasm has waned, it has not vanished. Looking six months, the bulk in CME Group’s Fed Watch survey anticipate the Fed Funds charge to be 100 foundation factors decrease.

Supply: CME Group

We’ll place our bets and see what occurs.